Is It Okay As Long as You Make a Profit? Evidence Based on Biased Discretionary Bonus Adjustments

Abstract

To prevent unethical behaviours by managers and employees, many companies include compliance aspects in their compensation schemes. For example, ex post discretionary adjustments allow managers to react to unforeseen events, such as dishonest behaviour. We propose that the level of ex post adjustments due to a subordinate’s misconduct depends on the subordinate’s ex ante financial performance. We further propose that this effect is reduced when the superior must justify his/her decision to adjust the subordinate’s bonus. Through an experiment, we find evidence confirming our hypotheses. The participants’ subjective ex-post bonus reduction is lower (higher) when the subordinates’ ex-ante objective performance is higher (lower). Additionally, our data show that increasing the superiors’ accountability through justification reduces the spill-over effect. Our research can help companies understand how and why superior managers (in-)sufficiently react to subordinates’ unethical behaviour and can help the development of remuneration schemes that are less vulnerable to judgemental biases.